Chapter 1
Introducing
Economic
Development:
A Global
Perspective
1.1 How the Other Half Live
• When one is poor, she has no say in public, she feels inferior. She
has no food, so there is famine in her house; no clothing, and no
progress in her family.
—A poor woman from Uganda
• For a poor person everything is terrible—illness, humiliation, shame.
We are cripples; we are afraid of everything; we depend on everyone.
No one needs us. We are like garbage that everyone wants to get rid
of.
—A blind woman from Tiraspol, Moldova
• Life in the area is so precarious that the youth and every able person
have to migrate to the towns or join the army at the war front in order
to escape the hazards of hunger escalating over here.
—Participant in a discussion group in rural Ethiopia
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1-2
1.1 How the Other Half Live
• When food was in abundance, relatives used to share it. These days
of hunger, however not even relatives would help you by giving you
some food.
—Young man in Nichimishi, Zambia
• We have to line up for hours before it is our turn to draw water.
—Mbwadzulu Village (Mangochi), Malawi
• [Poverty is] . . . low salaries and lack of jobs. And it’s also not
having medicine, food, and clothes.
--Discussion group,
Brazil
• Don’t ask me what poverty is because you have met it outside my
house. Look at the house and count the number of holes. Look at
the utensils and the clothes I am wearing. Look at everything and
write what you see. What you see is poverty. —Poor man in
Kenya
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1.1 How the Other Half Live
• A universal theme reflected in these quotes
is that poverty is more than lack of income –
it is inherently multidimensional, as is
economic development.
• Developing or Less Developed countries
characterized by low levels of living and other
development deficits. E.g. (Asia, Africa, the
Middle East, Latin America, eastern Europe, and
the former Soviet Union)
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1.1 How the Other Half Live
• How should poverty be defined?
– the international standard of extreme poverty is set to the
possession of less than 1$ a day. (unesco.org)
– Poverty is a state or condition in which a person or
community lacks the financial resources and essentials to
enjoy a minimum standard of life and well-being that's
considered acceptable in society. (investopedia.com)
– Or maybe: For what does it profit a man to gain the
whole world and to lose his soul? (Jesus Christ)
– Or possibly pastor Oliver definition:
https://www.youtube.com/watch?v=RGSvDvDZnb4
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1.1 How the Other Half Live
• Absolute vs. relative poverty
• Absolute poverty A situation of being unable to
meet the minimum levels of income, food, clothing,
healthcare, shelter, and other essentials.
• Relative poverty defines poverty in relation to the
economic status of other members of the society:
people are poor if they fall below prevailing
standards of living in a given societal context.
(unesco.org)
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1.1 How the Other Half Live
• Development The process of improving the
quality of all human lives and capabilities by
raising people’s levels of living, self-esteem,
and freedom.
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1.2 Economics and Development
Studies
– Traditional economics An approach that
stresses utility, profit maximization, market
efficiency, and determination of equilibrium.
– Political economy studies the social and
institutional processes through which certain
groups of economic and political elites influence
the allocation of scarce productive resources,
either for their own benefit exclusively or for
that of the larger population as well — to view
economic activity in its political context.
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1-8
1.2 Economics and Development
Studies
– The Nature of Development Economics
• Greater scope than traditional neoclassical economics
and political economy.
• The study of how economies are transformed from
stagnation to growth and from low income to highincome status, and overcome problems of absolute
poverty.
• Development economics must encompass the study of
institutional and social, as well as economic,
mechanisms for modernizing an economy while
eliminating absolute poverty.
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1-9
1.2 Economics and Development
Studies
– Why Study Development Economics?
Some Critical Questions
• Real meaning of development? (Chapter 1)
• What are economic institutions, and their role for
successful development? (Chapter 2)
• Sources of national and international economic
growth? (Chs. 2 & 3)
• Most influential theories of development? (Ch. 3)
• Causes of extreme poverty? Policies most effective for
improving the lives of the poorest of the poor? (Chs.
5, 6, 7, 8)
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1.2 Economics and Development
Studies
– Why Study Development Economics?
Some Critical Questions
• Is population growth a threat to economic
development (Ch. 6)
• High level of unemployment and migration to cities?
(Ch. 7)
• Richer means more educated and healthier. Is the
opposite true? (Ch. 8)
• Is trade a driver for economic development? (Ch. 12)
• Impact of foreign aid on developing countries (Ch.
14)
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Figure 1.1 World Income Distribution
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1.2 Economics and Development
Studies
• Economies as Social Systems: The Need to Go
Beyond Simple Economics
• Social Systems
– Interdependent relationships between economic and noneconomic factors such as values, attitudes and traditions.
• Success or failure of development policy
– Importance of taking account of institutional and structural
variables along with more traditional economic variables
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1.3 What Do We Mean by
Development?
• Traditional Economic Measures
– Gross National Income (GNI)
– Income per capita
– Economies should grow at higher rate than
population
– Emphasis on GDP
– Utility of that income?
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1.3 What Do We Mean by
Development?
• The New Economic View of
Development
– Leads to improvement in wellbeing
– Values and attitudes
– Institutions Norms, rules of conduct, and
generally accepted ways of doing things.
Economic institutions are humanly devised
constraints that shape human interactions
including both informal and formal “rules of the
game” of economic life
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1.3 What Do We Mean by
Development?
• Amartya Sen’s “Capability” Approach
– The capability to function is what’s important (Functionings
as an achievement)
– Capabilities as freedoms enjoyed in terms of functionings
– Development and happiness
– Well being in terms of being well and having freedoms of
choice
– “Beings and Doings”
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Some Key “Capabilities”
• Some Important “Beings” and “Doings” in
Capability to Function:
–
–
–
–
–
–
–
–
Being able to live long
Being well-nourished
Being healthy
Being literate
Being well-clothed
Being mobile
Being able to take part in the life of the community
Being happy – as a state of being - may be valued as a
functioning
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1.3 What Do We Mean by
Development? (cont’d)
• Three Core Values of Development
– Sustenance: The Ability to Meet Basic
Needs
– Self-Esteem: To Be a Person
– Freedom from Servitude: To Be Able to
Choose
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Figure 1.2 Income and Happiness:
Comparing Countries
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1.3 What Do We Mean by
Development? (cont’d)
• The Central Role of Women
– To make the biggest impact on development,
societies must empower and invest in women
• The Three Objectives of Development
– Increase availability of life-sustaining goods
– Raise levels of living
– Expand range of economic and social choices
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1.4 The Millennium Development
Goals
• Millennium Development goals (MDGs)
– Eight goals adopted by the United Nations in
2000
•
•
•
•
•
•
•
•
Eradicate extreme poverty and hunger
Achieve universal primary education
Promote gender equality and empower women
Reduce child mortality
Improve maternal health
Combat HIV/AIDS, malaria, and other diseases
Ensure environmental sustainability
Develop a global partnership for development
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Table 1.1 Millennium Development
Goals and Targets for 2015
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Table 1.1 Millennium Development Goals and
Targets for 2015 (cont’d)
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1.5 Conclusions
• The importance of Development Economics
• Inclusion of non-economic variables in
designing development strategies
• Achieving the Millennium Development
Goals
• “…One future-or none at all”
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Concepts for Review
•
•
•
•
•
•
•
•
•
•
Absolute Poverty
Attitudes
Capabilities
Developing countries
Development
Development economics
Freedom
Functionings
Globalization
Gross domestic product
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• Gross national income
(GNI)
• Income per capita
• Institutions
• Less developed countries
(LDCs)
• Millennium Development
Goals (MDGs)
• More developed countries
(MDCs)
• Political economy
1-25
Concepts for Review (cont’d)
•
•
•
•
•
•
Self-esteem
Social system
Subsistence economy
Sustenance
Traditional economics
Values
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Chapter 2
Comparative
Economic
Development
Objectives
• Some key development factors such
as education gender inequality.
• Introduction to the Human
Development Index (HDI) and how it
is calculated
• Introduction to the New Human
Development Index (NHDI) and how
it is calculated
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2-2
Common characteristics of developing
countries
• These features in common are on average and with
great diversity, in comparison with developed
countries:
– Lower levels of living and productivity
– Lower levels of human capital
– Higher levels of inequality and absolute poverty
– Higher population growth rates
– Greater social fractionalization
– Larger rural population - rapid migration to cities
– Lower levels of industrialization and manufactured
exports
– Adverse geography
– Underdeveloped financial and other markets
– Colonial Legacies - poor institutions etc.
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2.1 Defining the Developing World
• World Bank Scheme- ranks countries on
GNP/capita
–
–
–
–
LICS: Low Income Countries
LMC: Low Middle Income Countries
UMC: Upper Middle Income Countries
HIC: High Income Countries
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2.1 Defining the Developing World
• World Bank Scheme- ranks countries on
Gross National Income GNI/capita (2011)
• Low Income Countries
– GNI/Capita $12476
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Table 2.1 Classification of Economies by
Region and Income, 2013
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Table 2.1 Classification of Economies by Region and
Income, 2013 (continued)
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Table 2.1 Classification of Economies by Region and
Income, 2013 (continued)
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2-8
Figure 2.1 Nations of the World,
Classified by GNI Per Capita
Source: Data from Atlas of Global Development, 4th ed., pp. 16-17: World Bank and Collins. 2013. ATLAS OF GLOBAL DEVELOPMENT: A VISUAL GUIDE TO THE WORLD’S GREATEST CHALLENGES, FOURTH
EDITION. Washington, DC and Glasgow: World Bank and Collins. doi: 10.1596/978-0-8213-9757-2. License: Creative Commons Attribution CC BY 3.0
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How to compare income across
countries
• http://www.open.edu/openlearn/science-mathstechnology/mathematics-and-statistics/howcompare-income-across-countries
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2.2 Basic Indicators of Development: Real
Income, Health, and Education
• Gross National Income (GNI):
– Nation’s gross domestic product (GDP)
+ net income received from overseas.
– Gross national income (GNI) is defined as the sum of
value added by all producers who are residents in a
nation, plus net income received from abroad such as
employee compensation and property income. GNI
measures income received by a country both domestically
and from overseas. Source: Investopedia .
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2.2 Basic Indicators of Development: Real
Income, Health, and Education
• Gross National Income (GNI):
– The gross national income (GNI) is the total
domestic and foreign output claimed by
residents of a country, consisting
of gross domestic product (GDP), plus factor
incomes earned by foreign residents, minus
income earned in the domestic economy by
nonresidents
– GNI is slightly higher than GDP
– In some cases GNI is lower than GDP (in case the income
received by the country < payments made to the rest of
the world)
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2-12
2.2 Basic Indicators of Development: Real
Income, Health, and Education
• Gross Domestic Product (GDP)
– Gross domestic product (GDP) is the monetary
value of all the finished goods and services
produced within a country's borders in a specific
time period.
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2-13
Figure 2.2 Income Per Capita in Selected
Countries, 2011
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2.2 Basic Indicators of Development:
Real Income, Health, and Education
• PPP method instead of exchange rates as
conversion factors (see Figure 2.2)
• PPP takes into account
– International prices for goods and services
– Number of units of a foreign country’s currency
required to purchase the identical quantity of
goods and services in the local developing
country market as $1 would buy in the United
States
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2-15
Table 2.2 A Comparison of
Per Capita GNI in Selected
Developing Countries, the
United Kingdom, and the
United States, Using Official
Exchange-Rate and
Purchasing Power Parity
Conversions, 2011
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2-16
2.3 Holistic Measures of Living
Levels and Capabilities
• Health
–
–
–
–
life expectancy
the rate of undernourishment
the under-5 mortality rate
the crude birth rate
• Life Expectancy at birth
• Education:
• Adult literacy (male, female)
• Gross school enrollment
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2-17
Table 2.3
Commonality and
Diversity: Some
Basic Indicators
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2-18
2.3 Holistic Measures of Living
Levels and Capabilities
• Traditional Human Development Index
• HDI as a holistic measure (0 to 1) of living levels
– An index measuring national socioeconomic development,
based on combining measures of education, health, and
adjusted real income per capita.
• HDI ranks countries into four groups:
–
–
–
–
low human development (0.0 to 0.499)
medium human development (0.50 to 0.799)
high human development (0.80 to 0.90)
very high human development (0.90 to 1.0)
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Table A2.1.1 2009 Traditional Human
Development Index for 24 Selected Countries
(2007 Data)
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Table A2.1.2 2009 Human Development Index
Variations for Similar Incomes (2007 Data)
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Figure A2.1.1 Human Development Disparities
within Selected Countries
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Figure A2.1.1 Human Development Disparities
within Selected Countries (continued)
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2-23
2.3 Holistic Measures of Living Levels
and Capabilities
• The New Human Development Index
• Introduced by UNDP in November 2010
• HDI as a holistic measure of living levels
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2-24
NHDI
• Component index =
Country actual achievement – minimum goalpost
Divided by
Overall max goalpost – min goalpost
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Box 2.1 Computing the New HDI: Ghana
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Table 2.4 2013 New Human Development
Index and its Components for Selected Countries
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What is new in the New HDI?
1. Calculating with a geometric mean
• How does the New HDI compare with the better-known (but
no longer active) Traditional HDI?
• Probably most consequential: The index is now computed
with a geometric mean, instead of an arithmetic mean
• A geometric mean is also used to build up the overall
education index from its two components
• Traditional HDI added the three components and divided by 3
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2-28
What is new in the New HDI?
1. Calculating with a geometric mean
• New HDI takes the cube root of the product of the three
component indexes
• The traditional HDI calculation assumed one component
traded off against another as perfect substitutes, a strong
assumption
– Higher value for health index for instance would
compensate (1 for 1) for a lower value of education index
• The reformulation now allows for imperfect substitutability
which development specialists widely consider a more
plausible way to frame the tradeoffs.
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2-29
What is new in the New HDI?
2. Other key changes:
• Gross national income per capita replaces gross domestic
product per capita
• Revised education components: now using the average actual
educational attainment of the whole population, and the
expected attainment of today’s children
• The maximum values in each dimension have been increased
to the observed maximum rather than given a predefined
cutoff
• The lower goalpost for income has been reduced due to new
evidence on lower possible income levels
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2-30
2.3 Holistic Measures of Living
Levels and Capabilities
• HDI can be calculated for groups and regions in a
country
– HDI varies among groups within countries
– HDI varies across regions in a country
– HDI varies between rural and urban areas
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2-31
2.4 Characteristics of the Developing
World: Diversity within Commonality
• These ten characteristics are common among developing
countries – on average and with great diversity - in
comparison with developed countries:
1. Lower levels of living and productivity
2. Lower levels of human capital (health, education, skills)
3. Higher Levels of Inequality and Absolute Poverty
– Absolute Poverty
(deprivation of basic human needs)
4. Higher Population Growth Rates
– Crude Birth rates
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2-32
Figure 2.3a Shares of Global Income, 2008. (b)
Developing regions lag far behind the developed
world in productivity measured as output per worker.
Source: Figure 2.3a, Data from World Bank, World Development Indicators 2013 (Washington, D. C.: World Bank, 2013), p.24.
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2-33
Figure 2.3b Developing
regions lag far behind the
developed world in
productivity measured as
output per worker.
Source: Figure 2.3b, United Nations, Millenium Development Goals Report 2012, p.9.
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2-34
Table 2.5 The 12 Most and Least Populated
Countries and Their Per Capita Income, 2008
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Figure 2.4 Under-5 Mortality Rates,
1990 and 2012
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Table 2.6 Primary School Enrollment and
Pupil-Teacher Ratios, 2010
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2-37
Figure 2.5 Correlation between Under-5
Mortality and Mother’s Education
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Figure 2.6 Number of People Living in
Poverty by Region, 1981–2008
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Table 2.7 Crude Birth Rates Around the World,
2012
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2-40
2.4 Characteristics of the Developing
World: Diversity within Commonality
5. Greater Social Fractionalization
e.g. deep social division
6. Larger Rural Populations but Rapid Rural-toUrban Migration
7. Lower Levels of Industrialization and
Manufactured Exports
8. Adverse Geography
– Resource endowments
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Table 2.8 The Urban Population in Developed
Countries and Developing Regions
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Table 2.9 Share of the Population Employed in the
Agricultural, Industrial, and Service Sectors in Selected
Countries, 2004–2008 (%)
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Table 2.10 Share of the Population Employed in the
Agricultural, Industrial, and Service Sectors in Selected
Countries, 1990–92 and 2008–2011 (%)
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2-44
2.4 Characteristics of the Developing
World: Diversity within Commonality
9.
Underdeveloped Financial and Other
markets
– Imperfect markets (no perfect competition)
– Incomplete information (efficiency?)
10. Colonial Legacy and External Dependence
– Institutions
– Private property
– Personal taxation
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2-45
2.5 How Low-Income Countries Today
Differ from Developed Countries in Their
Earlier Stages
• Eight differences
– Physical and human resource endowments
– Per capita incomes and levels of GDP in relation to the rest
of the world
– Climate differences
– Population size, distribution, and growth
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2-46
2.5 How Low-Income Countries Today
Differ from Developed Countries in Their
Earlier Stages
• Eight differences
– Historic role of international migration (Brain drain)
– International trade benefits
• Except for few countries, many developing countries could not
benefit from international trade
– Basic scientific/technological research and development
capabilities
– Efficacy of domestic institutions
• less political stability and social flexibility
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2-47
2.6 Are Living Standards of Developing
and Devolved Nations Converging?
• Convergence: the catch up effect where
developing countries move towards higher income
as developed countries
• Evidence of unconditional convergence is hard to
find
• But there is increasing evidence of “per capita
income convergence,” weighting changes in per
capita income by population size
• (Also, in chapter 3, we return to examine the
concept of conditional convergence when we study
the Solow model)
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2-48
Figure 2.7 Relative Country Convergence:
World, Developing Countries, and OECD
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2-49
Figure 2.8 Growth Convergence versus
Absolute Income Convergence
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2-50
Figure 2.9 Country Size, Initial Income
Level, and Economic Growth
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2-51
2.7 Long-Run Causes of Comparative
Development
• What can explain the variation between
developing and developed economies?
• Schematic Representation
– Geography
– Institutional quality- colonial and post-colonial
– Colonial legacy- pre colonial comparative
advantage
– Evolution and timing of European development
– Inequality- human capital
– Type of colonial regime
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2-52
Figure 2.10
Schematic
Representation of
Leading Theories of
Comparative
Development
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2-53
Nature and Role of Economic
Institutions
• Institutions provide “rules of the game” of
economic life
• Provide underpinning of a market economy
• Include property rights; contract enforcement
• Can work for improving coordination,
• Restricting coercive, fraudulent and anticompetitive behavior
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2-54
Nature and Role of Economic
Institutions
• Providing access to opportunities for the broad
population• Constraining the power of elites, and managing conflict
• Provision of social insurance
• Provision of predictable macroeconomic stability
• Note: These institutions are correlated and it is not clear
which of these institutions matter most; and
“transitional institutions” may help in the development
process
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2-55
Role of Institutions
• Acemoglu, Johnson, and Robinson’s
“reversal of fortune” and extractive
institutions
• Bannerjee and Iyer, “property rights
institutions.” Landlords versus cultivators
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2-56
Concepts for Review
•
•
•
•
•
•
•
Absolute poverty
Brain drain
Capital stock
Convergence
Crude birth rate
Dependency burden
Depreciation (of the capital
stock)
• Diminishing Marginal Utility
• Divergence
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•
•
•
•
Economic Institutions
Fractionalization
Free trade
Gross domestic product
(GDP)
• Gross national income
(GNI)
• Human capital
• Human Development Index
(HDI)
2-57
Concepts for Review (cont’d)
•
•
•
•
•
Imperfect market
Incomplete information
Infrastructure
Least developed countries
Low-income countries
(LICs)
• Middle-income countries
• Newly industrializing
countries (NICs)
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• Purchasing power parity
(PPP)
• Research and development
(R&D)
• Resource endowment
• Terms of trade
• Value added
• World Bank
2-58
Chapter 3
Classic Theories
of Economic
Growth and
Development
Objectives
• How and why development does or does
not take place
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3-2
3.1 Classic Theories of Economic
Development: Four Approaches
• Linear stages of growth model
• Theories and Patterns of structural change
• International-dependence revolution
• Neoclassical, free market counterrevolution
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3-3
3.2 Development as Growth and
Linear-Stages Theories
• A Classic Statement: Rostow’s Stages of
Growth
• Harrod-Domar Growth Model (sometimes
referred to as the AK model)
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3-4
3.2 Development as Growth and
Linear-Stages Theories
• Process of development as a series of
successive stages of economic growth.
- Enablers: saving, investment, and
foreign aid
• A Classic Statement: Rostow’s Stages of
Growth
– Country passes through sequential stages in
achieving development.
– Saving → investment → economic growth
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3-5
The Harrod-Domar Model (AK)
• Y = AK
– A is constant
– K is capital
• Growth rate of gross domestic product (g)
depends directly on the national net
savings rate (s) and inversely on the
national capital-output ratio (c).
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3-6
The Harrod-Domar Model Simplified Version
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3-7
The Harrod-Domar Model Simplified Version
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3-8
The Harrod-Domar Model –
Incorporating Capital Depreciation
• Equation 3.7 is also often expressed in terms of
gross savings, in which case the growth rate is
given by
(3.7’)
where δ is the rate of capital depreciation
• But there is now growing evidence of “per capita
income convergence,” weighting changes in per
capita income by population size
• (Also, in chapter 3, we return to examine the
concept of conditional convergence when we study
the Solow model)
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3-9
Criticisms of the Stages Model
• Limitations of the Harrod-Domar Growth Model
– Increasing savings ratios in lower-income
countries is difficult. Extra income earned is
spent on more consumption
– Dis-functional financial system
– Higher productivity (reducing the capital output
ratio) is hard to achieve. Capital is used
inefficiently
– Filling the savings gap by borrowing from
overseas will bring a debt burden
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3-10
Criticisms of the Stages Model
• Necessary versus sufficient conditions
– Saving and investment are both necessary
conditions for growth but they are not sufficient
conditions
• For growth to continue, social, institutional,
and attitudinal changes may also have to
take place.
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3-11
3.3 Structural-Change Models
• Structural-change theory The
hypothesis that underdevelopment is due
to underutilization of resources.
• Development needs more than just
accelerated capital formation.
• Structural transformation The process
of transforming an economy: the
contribution to national income by the
manufacturing sector eventually surpasses
the agricultural sector.
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3-12
3.3 Structural-Change Models
• The Lewis two-sector model
• Surplus of labor: move labor from
agricultural sector to the industrial one
without loss of output
• Modern sector has growth of output
• Profits generated over wages (no fear that
wages will rise) get reinvested
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3-13
Figure 3.1 The
Lewis Model of
Modern-Sector
Growth in a
Two-Sector
Surplus-Labor
Economy
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3-14
Criticisms of the Lewis Model
• Rate of labor transfer and employment creation
may not be proportional to rate of modern-sector
capital accumulation
– (fig 3.2 where KM2 technology requires less
labor per unit of output than Km1)
• Surplus labor in rural areas and full employment in
urban?
– Data indicates that there is little labor surplus in
rural, developing countries
• Model assumes that wages in the modern sector
remain constant. Evidence showed that wages tend
to rise in many developing countries.
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3-15
Figure 3.2 The Lewis Model Modified by
Laborsaving Capital Accumulation: Employment
Implications
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3-16
Criticisms of the Lewis Model
• Institutional factors?
• The transfer of unskilled workers from
agriculture to industry is regarded as almost
smooth and costless
• Assumption of diminishing returns in modern
industrial sector
– Evidence from some developing countries shows
increasing returns prevailing in that sector
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3-17
Structural Change and patterns
of Development Analysis
• Similar to the Lewis model, this model
focuses on structural change as economic
development takes the form of sequential
process
• Economic, industrial and institutional
structure of the economy is transformed to
allow new industries to replace traditional
agriculture over time
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3-18
Empirical Patterns of
Development - Examples
• Switch from agriculture to industry (and
services)
• Rural-urban migration and urbanization
• Steady accumulation of physical and human
capital
• Population growth first increasing and then
decreasing with decline in family size
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3-19
3.4 The InternationalDependence Revolution
• International-dependence models view
developing countries as troubled by
institutional, political, and economic
rigidities, both domestic and international,
and caught up in
a dependence and dominance relationship
with rich countries.
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3-20
3.4 The InternationalDependence Revolution
• Within this general approach of
International-dependence models there are
three major streams of thought
1. The neo-colonial dependence model
2. The false-paradigm model
3. The dualistic-development thesis.
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3-21
3.4 The InternationalDependence Revolution
• 1. The neocolonial dependence model
– Legacy of colonialism, Unequal power, Core-periphery
– Emphasizes the unequal power relationships between the
developed and less developed countries
– Blames underdevelopment on conscious or unconscious
developed country exploitation
– Inequality within each developing country, where a small
ruling elite controls the means of production.
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3-22
3.4 The InternationalDependence Revolution
• 2. The false-paradigm model
– Pitfalls of using “expert” foreign advisors who
misapply developed-country models
• 3. The dualistic-development thesis
– Superior and inferior elements can coexist e.g.
traditional and modern methods of production
leading to a coexistence of wealth and poverty
– This coexistence is chronic and not merely
transitional
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3-23
3.4 The InternationalDependence Revolution
• Criticisms and limitations of the International
Dependence Revolution
– Does little to show how to achieve development
in a positive sense
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3-24
3.5 The Neoclassical Counterrevolution:
Market Fundamentalism
• This theory is also known as neo-liberal theory.
• 1980s and 1990s, the neoclassical or free-market
counterrevolution approach prevailed.
• It emphasizes the beneficial role of free markets,
open economies, and the privatization of inefficient
public enterprises.
• Failure to develop, according to this theory, is not
due to exploitive internal and external forces as
expounded by dependence theorists. Rather, it is
primarily the result of too much government
intervention and regulation of the economy.
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3-25
3.5 The Neoclassical Counterrevolution:
Market Fundamentalism
• The neo-classical approach states that
underdevelopment arises from:
• Poor resource allocation due to incorrect price
policies, and Government’s intervention in the
economic activities.
• Neo-classical or neo-liberal approach states that
economic growth can be put to spur by:
–
–
–
–
–
Permitting competitive free markets to flourish,
Privatising state-owned enterprises,
Promoting free trade and export expansions,
Welcoming investors from developed economies, and
Eliminating the excessive amount of government
regulations and price distortions in factor, product and
market.
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3-26
3.5 The Neoclassical Counterrevolution:
Market Fundamentalism
• Challenging the Statist Model: Free Markets, Public
Choice, and Market-Friendly Approaches
• Free market approach
– Economies free of government regulations perform better
• Public Choice approach
– Governments corrupt and inefficient since individuals use
them to pursue own agenda
• Market-friendly approach
– Government should only intervene in case of market
failure
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3-27
3.5 The Neoclassical Counterrevolution:
Market Fundamentalism
• Main Arguments
– Denies efficiency of intervention
– Points up state owned enterprise failures
– Stresses government failures
– Traditional neoclassical growth theory - with
diminishing returns, cannot sustain growth by
capital accumulation alone
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3-28
The Solow model
• due to Robert Solow, won Nobel Prize for
contributions to the study of economic
growth
• a major paradigm:
– widely used in policy making
– benchmark against which most
recent growth theories are compared
• looks at the determinants of economic
growth and the standard of living in the
long run
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3-29
The production function
• In aggregate terms:
• Define:
Y = F (K, L)
y = Y/L = output per worker
k = K/L = capital per worker
• Assume constant returns to scale:
zY = F (zK, zL ) for any z > 0
• Pick z = 1/L. Then
Y/L = F (K/L, 1)
y = F (k, 1)
y = f(k)
where f(k) = F(k, 1)
f(k) is the per worker production
function
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3-30
Saving and investment
• saving (per worker) = sy
• National income identity is y = c + i
Rearrange to get:
i = y – c = sy
• Using the results above,
i = sy = sf(k)
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3-31
Output, consumption, and
investment
Output per
worker, y
f(k)
c1
sf(k)
y1
i1
k1
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Capital per
worker, k
3-32
Depreciation
Depreciation per
worker, k
= the rate of depreciation
= the fraction of the capital stock
that wears out each period
k
1
Capital per
worker, k
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3-33
Capital accumulation
The basic idea: Investment increases the
capital stock, depreciation reduces it.
Change in capital stock
k
= investment – depreciation
=
i
– k
Since i = sf(k) , this becomes:
k = s f(k) – k
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3-34
The equation of motion for k
• With population growth,
the equation of motion for k is:
k = s f(k) − ( + n) k
actual
investment
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break-even
investment
3-35
Figure A3.2.1 Equilibrium in the
Solow Growth Model
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3-36
Figure A3.2.2 The Long-Run Effect of
Changing the Saving Rate in the Solow Model
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3-37
The Solow model diagram
k = s f(k) − ( +n)k
( + n ) k
sf(k)
k*
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Capital per
worker, k
3-38
The impact of population growth
( +n2) k
( +n1) k
An increase in n
sf(k)
leads to a lower
steady-state level of
k.
k 2*
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k1* Capital per
worker, k
3-39
Growth and the PPF
• Production possibility curve
• A curve on a graph indicating alternative
combinations of two commodities or
categories of commodities (e.g., agricultural
and manufactured goods) that can be
produced when all the available factors of
production are efficiently employed.
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3-40
PPF
• Production possibility curve and the
effects on growth
– Effects of physical and human resources
– Effects of capital stock and land
– Effects of technology
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3-41
Figure A3.1.1 Effect of Increases in Physical and Human
Resources on the Production Possibility Frontier
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3-42
Figure A3.1.2 Effect of Growth of Capital Stock
and Land on the Production Possibility Frontier
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3-43
Figure A3.1.3 Effect of Technological Change
in the Agricultural Sector on the Production
Possibility Frontier
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3-44
Figure A3.1.4 Effect of Technological Change
in the Industrial Sector on the Production
Possibility Frontier
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3-45
3.6 Classic Theories of Development:
Reconciling the Differences
• Governments do fail, but so do markets; a balance is
needed
• Must attend to institutional and political realities in
developing world
• Development economics has no universally accepted
paradigm
• Insights and understandings are continually evolving
• Each theory has some strengths and some weaknesses
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3-46
Concepts for Review
•
•
•
•
•
•
•
•
•
Autarky
Average product
Capital-labor ratio
Capital-output ratio
Center
Closed economy
Comprador groups
Dependence
Dominance
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•
•
•
•
•
Dualism
False-paradigm model
Free market
Free-market analysis
Harrod-Domar growth
model
• Lewis two-sector model
• Marginal product
• Market failure
3-47
Concepts for Review (cont’d)
• Market-friendly approach
• Necessary condition
• Neoclassical
counterrevolution
• Neocolonial dependence
model
• Net savings ratio
• New political economy
approach
• Open economy
• Patterns-of-development
analysis
• Periphery
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•
•
•
•
•
•
•
•
•
•
Production function
Public-choice theory
Self-sustaining growth
Solow neoclassical growth
model
Stages-of-growth model of
development
Structural-change theory
Structural transformation
Sufficient condition
Surplus labor
Underdevelopment
3-48
Appendix 3.1: Components of
Economic Growth
• Capital Accumulation, investments in
physical and human capital
– Increase capital stock
• Growth in population and labor force
• Technological progress
– Neutral, labor/capital-saving, labor/capital
augmenting
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3-49
Appendix 3.2 The Solow
Neoclassical Growth Model
Y L = f (K L ,1) or y = f (k )
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3-50
Appendix 3.2 The Solow
Neoclassical Growth Model
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3-51
Appendix 3.2 The Solow
Neoclassical Growth Model
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3-52
Chapter 8
Human Capital:
Education and
Health in
Economic
Development
8.1 The Central Roles of
Education and Health
• Health and education are important
objectives of development, as reflected in
Amartya Sen’s capability approach, and in
the core values of economic development
• Health and education are also important
components of growth and development –
inputs in the aggregate production function
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8-2
Education and Health as Joint
Investments for Development
• These are investments in the same individual
• Greater health capital may improve the
returns to investments in education
– Health is a factor in school attendance
– Healthier students learn more effectively
– A longer life raises the rate of return to
education
– Healthier people have lower depreciation of
education capital
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8-3
Education and Health as Joint
Investments for Development
• Greater education capital may improve
the returns to investments in health
–Public health programs need
knowledge learned in school
–Basic hygiene and sanitation may be
taught in school
–Education needed in training of health
personnel
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8-4
Improving Health and Education:
Increasing Incomes Is Not Sufficient
• Increases in income often do not lead to
substantial increases in investment in
children’s education and health
• But better educated mothers tend to have
healthier children at any income level
• Significant market failures in education and
health require policy action
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8-5
Figure 8.1 Age-Earnings Profiles by
Level of Education: Venezuela
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8-6
8.2 Investing in Education and
Health: The Human Capital Approach
• Initial investments in health or education
lead to a stream of higher future income
• The present discounted value of this stream
of future income is compared to the costs of
the investment
• Private returns to education are high, and
may be higher than social returns,
especially at higher educational levels
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8-7
Figure 8.2 Financial Trade-Offs in the
Decision to Continue in School
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8-8
Table 8.1 Returns to Investment in Education
by Level, Regional Averages (%)
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8-9
8.3 Child Labor
• Child labor is a widespread phenomenon
• The problem may be modeled using the
“multiple equilibria” approach
• Government intervention may be called for
to move to a ‘better’ equilibrium
• Sometimes this shift can be self-enforcing,
so active intervention is only needed at first
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8-10
Assumptions of the Child Labor
Multiple Equilibria Model
• 2 assumptions to model child labor :
– Luxury (wealth) Axiom: A household with
sufficiently high income would not send its
children to work
– Substitution Axiom: Adult and child labor are
substitutes, in which the quantity of output by a
child is a given fraction of that of an adult: QC =
γQA, 0 < γ < 1.
– Labor is unskilled labor
– Supply of labor is in adult equivalents
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8-11
Figure 8.3 Child Labor as a Bad
Equilibrium
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8-12
Other approaches to child labor
policy
• Get more children into school (as in Millennium Development
Goals), e.g. new village schools; and enrollment incentives for
parents (e.g. in Brazil)
• Consider child labor an expression of poverty, so emphasize
ending poverty generally
• If child labor is inevitable in the short run, regulate it to prevent
abuse and provide support services for working children (UNICEF
approach)
• Ban child labor; or if impossible, ban child labor in its most abusive
forms (ILO strategy; “Worst Forms of Child Labor Convention”)
• Activist approach: trade sanctions. Concerns: could backfire when
children shift to informal sector; and if modern sector growth slows
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8-13
8.4 The Gender Gap: Discrimination
in Education and Health
• Young females receive less education than young males in
nearly every low and lower-middle income developing
country
• Closing the educational gender gap is important because:
– The social rate of return on women’s education is higher
than that of men in developing countries
– Education for women increases productivity, lowers
fertility
– Educated mothers have a multiplier impact on future
generations
– Education can break the vicious cycle of poverty and
inadequate schooling for women
– Good news: Millennium Development Goals on parity
being approached, progress in every developing region
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8-14
Figure 8.4 Youth Literacy Rate,
2008
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8-15
The “Missing Women” Crisis
• Research has concluded that in Asia at least 100
million women or more are “missing”
• Some women are also missing in Africa, but a
much smaller proportion
• Reasons include inferior medical care for girls, and
gender selective abortion or female infanticide
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8-16
Figure 8.5 Estimated Percent of Women
“Missing”
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8-17
8.5 Educational Systems and
Development
• The Political Economy of Educational Supply and
Demand: The Relationship between Employment
Opportunities and Educational Demands
– Demand: desire for education is influenced by future
earnings and cost of schooling
– Supply: determined largely by the political process
(unrelated to the economics)
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8-18
8.5 Educational Systems and
Development
• Social versus Private Benefits and Costs
– Private benefits: benefits that accrue directly to an
individual economic unit. For example, private benefits of
education are those that directly accrue to a student and
his or her family
– Social benefits of education: Benefits of the schooling
of individuals, including those that accrue to others or
even to the entire society, such as the benefits of a more
literate workforce and citizenry.
– Social costs of education: Costs borne by both the
individual and society from private education decisions,
including government education subsidies.
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8-19
Figure 8.6 Private
versus Social
Benefits and Costs of
Education: An
Illustration
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8-20
8.5 Educational Systems and
Development
• Distribution of Education
– Lorenz curves for the distribution of education
• Education, Inequality, and Poverty
– Countries that have developed successfully
have generally ensured that educational
benefits are more broadly available in the
economy—to the poor as well as the rich, in the
rural areas as well as the urban.
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8-21
Figure 8.7 Lorenz Curves for Education in
India and South Korea
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8-22
8.5 Educational Systems and
Development (cont’d)
• In many developing countries the educational system tends
to increase inequality
• Educational supply and demand: the relationship between
employment opportunities and educational demands
• Social versus private benefits and costs
– The private cost of education is higher for poor families
(the opportunity cost of sending kids to school) while
expected benefit is lower
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8-23
8.5 Educational Systems and
Development (cont’d)
• Education, Internal Migration, and the Brain Drain
– Education influences rural-urban migration and also
immigration
• Brain Drain: the emigration of highly educated and skilled
professionals and technicians from the developing countries
to the developed world.
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8-24
8.6 Health Measurement and
Distribution
• World Health Organization (WHO): The key
United Nations agency concerned with
global health matters.
• Life expectancy improved in most regions
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8-25
Figure 8.9 Proportion of Children under 5 Who
Are Underweight, by Household Wealth, around
2008
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8-26
8.7 Disease Burden
• HIV/AIDS
• Malaria
• Parasitic Worms and Other “Neglected
Tropical Diseases”
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8-27
Figure 8.11
Global HIV Trends,
1990–2011
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8-28
Table 8.2 Regional HIV and AIDS Statistics, a
Decade of Bending the Curve, 2011 versus 2001
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8-29
8.8 Health, Productivity, and
Policy
• Productivity
– Is there a connection?
– Studies showed that healthier people earn
higher wages
• Health Systems Policy
– health system is “all the activities whose
primary purpose is to promote, restore, or
maintain health.” (WHO definition)
– Great variability in the performance of health
systems at each income level among countries
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8-30
Figure 8.12 Wages, Education, and Height of
Males in Brazil and the United States
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8-31
Concepts for Review
• Acquired immunodeficiency
syndrome (AIDS)
• Basic education
• Brain drain
• Conditional cash transfer
(CCT) programs
• Derived demand
• Discount rate
• Educational certification
• Educational gender gap
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• Health system
• Human capital
• Human immunodeficiency
virus (HIV)
• Literacy
• Neglected tropical diseases
• Private benefits of
education
8-32
Concepts for Review (cont’d)
•
•
•
•
Private costs of education
Social benefits of education
Social costs of education
World Health Organization
(WHO)
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8-33
Algebraic version of the schooling decision diagram
(Note: you can also do a rate of return calculation as in Endnote 19)
Net present value of Income Stream is given by
Yt - Xt - Ct
NPV = å
t
(1+ r)
t
(Compare with Equation 11.10)
Where:
t is time (year) from present. (The present is time t = 0.)
Yt is expected income from having gone to school, realized at time t
Xt is expected income from having NOT gone to school, at time t
Ct is the cost of going to school borne at time (if any)
r is the rate of discount used
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8-34
Chapter 11
Development
Policymaking
and the Roles of
Market, State,
and Civil Society
11.1 A Question of Balance
• Roles and Limitations of State, Market, and
the Citizen Sector/NGOs in Achieving
Economic Development and Poverty
Reduction
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11-2
11.2 Development Planning:
Concepts and Rationale
• The Planning Mystique (magic)
– In the past, few doubted the importance and
usefulness of national economic plans
– Recently, however, disillusionment has set in
– But a comprehensive development policy
framework can play an important role in
accelerating growth and reducing poverty
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11-3
11.2 Development Planning:
Concepts and Rationale (cont’d)
• The nature of development planning resource
mobilization for public investment
– Economic policy to control private economic activity
according to social objectives formulated by government
• Planning in mixed developing economies
• Private sector in mixed economies comprises
–
–
–
–
–
The subsistence sector
Small scale businesses
Medium size enterprises
Larger domestic firms
Large joint or foreign owned enterprises
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11-4
11.2 Development Planning:
Concepts and Rationale (cont’d)
• The Rationale for Development Planning
–
–
–
–
Market failure
Resource mobilization and allocation
Attitudinal or psychological impact
Requirement to receive foreign aid
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11-5
Three General Forms of Market
Failure
• Market Failure Forms:
• The market cannot function properly or no market
exists
• The market exists but implies inefficient resource
allocation
• More expansively: the market produces
undesirable results as measured by social
objectives other than the allocation of resources
– Often items such as more equal income
distribution, and “merit goods” such as health,
are treated as separate rationales for policy,
outside of economic efficiency
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11-6
Market Failure
• Market failures can occur when social costs or benefits
differ from private costs or benefits of firms or consumers
• Market power (monopolistic, monopsonistic)
• Public goods: free riders cannot be excluded except
possibly at high cost
• Externalities: agents do not have to pay all costs of their
activities, or are unable to receive all the benefits
• Capital markets are particularly prone to failure
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11-7
Market and Government Failure:
Broader Arguments
• Government failure: in many cases, politicians and
bureaucrats can be considered utility maximizers, not
public interest maximizers
• Developing countries tend to have both high market
failure and high government failures
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11-8
11.3 The Development Planning
Process: Some Basic Models
• Characteristics of the planning process
• Planning in stages: basic models
– Aggregate growth models
– Multisector input-output, social accounting, and
CGE models
• Three stages of planning
– Aggregate
– Sectoral
– Project
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11-9
11.3 The Development Planning
Process: Some Basic Models (cont’d)
Aggregate Growth Models: Projecting Macro
Variables
K (t ) = cY (t )
(11.1)
Where
K(t) is capital stock at time t
Y(t) is output at time t
c is the average and marginal
capital-output ratio
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11-10
11.3 The Development Planning Process:
Some Basic Models (Aggregate Growth
Models, cont’d)
(11.2)
Where
I(t) is gross investment at time t
s is the savings rate
S is national savings
is the depreciation rate
If g is the targeted rate of output growth, then
(11.3)
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11-11
11.3 The Development Planning Process:
Some Basic Models (Aggregate Growth
Models, cont’d)
(11.4)
(11.5)
(11.6)
Where n is the labor force growth rate and p
is the growth rate of labor productivity
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11-12
11.3 The Development Planning Process:
Some Basic Models (Aggregate Growth
Models, cont’d)
(11.7)
Where W and are wage and profit incomes
(11.8)
Where s and sW are the marginal propensities
to save from wage income and profit
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11-13
11.3 The Development Planning Process:
Some Basic Models (Aggregate Growth
Models, cont’d)
(11.9)
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11-14
11.3 The Development Planning
Process: Some Basic Models (cont’d)
• Multisector Models and Sectoral Projections
• Interindustry or input-output models
– Activities (output) of one sector are seen as
users of inputs from other industries
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11-15
11.3 The Development Planning
Process: Some Basic Models (cont’d)
• Project Appraisal and Social Cost-Benefit
Analysis
• Basic concepts and methodology
• To weight the advantages and disadvantages to society
as a whole.
• Computing shadow prices (prices which reflect the
opportunity cost of capital)
– Often market prices in developing countries do not
accurately reflect market prices because of a number of
factors such as: inflation, tariffs, subsidies, over or
undervalued currency and other market distortions
• Calculating the social rate of discount
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11-16
11.3 The Development Planning Process:
Some Basic Models (Project Appraisal and
Social Cost-Benefit Analysis, cont’d)
Net present value, or NPV is given by
Bt - Ct
NPV = å
t
t (1+ r)
(11.10)
Where
Bt is the expected benefit at time t
Ct is the expected cost at time t
r is the social rate of discount used
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11-17
11.3 The Development Planning Process:
Some Basic Models (Project Appraisal and
Social Cost-Benefit Analysis, cont’d)
• Choosing projects: some decision criteria
– NPV rule
– Use the IRR as a decision criterion
• Compare the internal rate of return (the return when
NPV=0) with an interest rate to decide whether to
accept the project or not
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11-18
11.4 Government Failure and
Preferences for Markets over Planning
• The 1980s policy shift toward free markets
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11-19
11.4 Government Failure and Preferences
for Markets over Planning (cont’d)
•
•
•
•
•
Problems of Plan Implementation and Plan Failure
Theory versus practice
Deficiencies in the plans and their implementation
Insufficient and or unreliable data
Unanticipated economic disturbances external (e.g.
sudden stop of foreign capital inflow), and internal
(e.g. change in oil prices)
• Institutional weaknesses
• Lack of political will
• Conflict, post-conflict, and fragile states
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11-20
11.5 The Market Economy
• Well functioning market economy requires
–
–
–
–
–
–
–
–
–
–
–
–
Clear property rights
Laws and courts
Freedom to establish business
Stable currency
Public supervision of natural monopolies
Provision of adequate information
Autonomous tastes (protection of consumers preferences from
the influence of powerful producers)
Public management of externalities
Stable monetary and fiscal policy instruments
Safety nets
Encouragement of innovation
Security from violence
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11-21
11.5 The Market Economy (cont’d)
• The “Washington Consensus” (in the 80s and 90s)
on the Role of the State in Development and its
Limitations
• The consensus reflected a free market approach to
development espoused by the IMF, the World
bank, and key U.S. government agencies
• However, it did not always accord with realities in
developing countries that were successful (see Box
11.1)
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11-22
Box 11.1 The Washington
Consensus and East Asia
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11-23
11.6 The Washington Consensus on the
Role of the State in Development and Its
Subsequent Evolution
• Toward a new consensus starting in 1998
– New emphasis on government's responsibility
toward poverty alleviation and inclusive growth
– Importance of health and education
– A recognition that markets can fail
– Governments can help secure conditions for an
effective market based economy
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11-24
11.7 Development Political Economy:
Theories of Policy Formulation and Reform
• Understanding voting patterns on policy
reform
– Sometimes voters reject a policy from which the
majority will benefit (lack of information)
• Democracy versus autocracy: which
facilitates faster growth?
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11-25
Figure 11.1 Global Trends in
Governance, 1946-2008
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11-26
11.8 Development Roles of NGOs and
the Broader Citizen Sector
• NGOs are non government organization meant
to provide financial and technical support for
development purposes
• Potentially important roles in:
– Helping poor countries design and implement
programs focused on poverty reduction
– Economic and productive ideas
– Specialized technical knowledge
– Trust and Credibility
– Representation and advocacy
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11-27
Other limitations: “voluntary
failure” – NGOs may be…
• Insignificant, owing to small scale and reach.
• Lacking necessary local knowledge to develop and
implement an appropriate mix of programs to address
relevant problems
• Lacking adequate incentives to ensure effectiveness
• Captured by goals of funders rather than intended
beneficiaries; may change priorities one year to the next
• Giving too little attention to means—such as
fundraising—can become ends in themselves
• Lacking immediate feedback (as private firms get in
markets, or elected governments receive at the polls);
this can let the weaknesses go on for some time before
being corrected
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11-28
11.9 Trends in Governance and
Reform
• Dealing with the problem of Corruption
– Control of public resources through the abuse of
official power or influence (Abuse of public trust
for private gain)
• Decentralization
– Developed countries have given more power to
state and local governments
• Development participation– Genuine participation by the people and role of
NGOs
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11-29
Figure 11.3 Corruption as a Regressive Tax:
The Case of Ecuador
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11-30
Figure 11.4 The Association between Rule
of Law and Per Capita Income
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11-31
11.9 Trends in Governance and
Reform (cont’d)
• Good governance enhances capability to
function
• Effects of corruption fall disproportionately
on the poor
• Good governance is broader than simply an
absence of corruption
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11-32
Concepts for Review
•
•
•
•
•
•
•
Accounting prices
Aggregate growth model
Comprehensive plan
Corruption
Cost-benefit analysis
Economic infrastructure
Economic plan
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•
•
•
•
•
•
•
•
Economic planning
Government failure
Input-output model
Interindustry model
Internal rate of return
Market failure
Market prices
Net present value
11-33
Concepts for Review (cont’d)
• Nongovernmental
organization (NGO)
• Partial plan
• Path dependency
• Planning process
• Political will
• Project appraisal
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•
•
•
•
•
Rent seeking
Shadow prices
Social profit
Social rate of discount
Voluntary failure
11-34
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